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5 lessons you should learn from the stock-market selloff

Warren Buffett knows when to be fearful and when to be greedy. Most investors, alas, do not.

“Be fearful when others are greedy, and greedy when others are fearful.”

Are you as tired of reading that as I am of writing it?

This isn’t even Investing 101. It’s the Cliff’s Notes cheat sheet for “Investing for Dummies.” The only principle to investing more rudimentary is “buy low and sell high.”

But obviously you need a refresher. Because you still buy high and sell low. You are terrified when others are fearful.

And greedy? Just what were you looking at this year when you kept buying stocks? The little green line that inched up and up? Your broker’s new sports car? Don’t try to hide it. I know you were buying. I saw the rally. You know, the one that was wiped off the books last week and yesterday.

Market analyst Doug Short had recently noted that the market was overvalued between 50% and an 90%.

Sorry. We need to get back to basics.

That’s why you need to see that quote again. Warren Buffett’s iconic statement about investing in volatile markets bears repeating especially after last week’s selloff that rendered the 2014 U.S equity markets a Mulligan.

So, let’s start over and consider what, if anything, we learned.

1. Easy money. Just because the Federal Reserve has set interest rates close to zero doesn’t mean anyone will borrow. U.S. companies will only borrow if they have the need. And because the Fed continues to signal that rates will remain low, there is no hurry to borrow. An even bigger reason companies aren’t borrowing? They can simply sell more stock at a premium the market has set. In other words, by buying stocks at inflated prices, you’re also providing them credit. Feel comfortable with that?

2. We’re in a global economy. In case you haven’t looked at the S&P 500 list lately, you might want to take a peek. You might notice that just about every name on the list has global operations or makes products and sells services that depend on imports and exports.

Now consider two reports. The first is by the International Monetary Fund and it came out Sunday. It wasn’t pretty. One analyst concluded “global growth is stuck in a rut.” The other report was published this summer by the World Bank. Itconcluded that developed “economies are expected to grow by 1.9% in 2014, accelerating to 2.4% in 2015 and 2.5% in 2016.” That sounds totally awesome. But does it justify the 9% rise in U.S. equities that we’ve seen this year? Not really.

Oh, and that same World Bank report? It added this: “We are not totally out of the woods yet. A gradual tightening of fiscal policy and structural reforms are desirable to restore fiscal space depleted by the 2008 financial crisis. In brief, now is the time to prepare for the next crisis.”

3. A lack of options is a matter of perspective. To many investors, the choice about where to invest basically came down to this: With bond yields in line with inflation, with the uncertainty of the housing market, the only attractive returns are in equities. Which is fine except ... didn’t we begin our lesson today with something about being greedy?

Everyone thought this way, which means you should either: A. Follow the herd and quit your job waiting for your big returns; or B. Be fearful when others are greedy. Oops. You picked A this year.

Until the recent selloff, the S&P 500 Index SPX, +0.16% was trading at 20 times price to earnings. The Shiller 10-year adjusted index for the index has P/E at 25 times, about the fourth-highest on record. OK, maybe bonds aren’t that attractive. How about cash? Those options look different now, don’t they?

4. This ratio: For the most recent completed quarter, companies issuing negative guidance outnumber those with positive guidance about 3 to 1 (82 to 27,according to FactSet).

5. Until things are better, they aren’t better. When this column last touchedon market valuation in July, it cited the most recent report on growth from the Bureau of Economic Analysis. The latest version of the report showed strong gross domestic product growth in the second quarter of 4.6%. So, yes, there is a strong indication the current earnings season will see increased profits. But how much? Market analyst Doug Short noted that as of Oct. 3, the market was still overvalued between 50% and an 90%. Yes, the market often leads a recovery, but this rally may have wandered too far ahead.

In other words, a lot of people are greedy. Of course, if you paid attention to your portfolio last week, you already knew that.